THE KEY FACTORS ARE LOW RATE OF
RETURN THAT IS INCOMMENSURATE WITH THE HIGH RATE OF INFLATION IN THE
COUNTRY

SHABBIR H. KAZMI
(feedback@pgeconomist.com)Mar
8 - 14, 2010

Reportedly growth in deposits has
remained subdued mainly due to rate of return which does not commensurate with
the inflation rate. Banks also attribute sluggish growth in deposits to higher
rates being offered by Central Directorate of National Savings. It may be partly
true but bulk of the investment in its schemes comes from those who do not use
bank services.

The best review of the banking system
comes from periodical reports of the central bank, latest being the quarter
ended September 30, 2009.

According to a banking sector analyst,
bulk of the deposits still remain with 'big five' who are neither interested in
mobilizing more deposits nor lending. Since their cost of funds is very low they
prefer to invest in market treasury bills and Pakistan Investment Bonds.
However, the exceptionally high exposure in equities market is a point of
concern because lately equities market has remained under pressure.

Some of the financial institutions also
ventured into Sukuk but experience is disappointing. Many of the companies
issuing Sukuk have defaulted and are seeking restructuring. It may not be wrong
to say that Shariah compliance was looked at only and hardly any attention was
paid of the financial conditions of the issuer.

Deposits of the banking system declined
marginally by 1.7% during the quarter. Disaggregated analysis of the deposits
shows that over the quarter decline was largely contributed by financial
institutions deposits and current accounts. However, the overall composition of
deposits remained more or less stable at previous quarter's level.

Banks made good the decline in deposits
through borrowings which increased by 11% by the end of quarter. However, the
internal composition of borrowings changed from unsecured to secured borrowings
as the increased level of GoP papers allowed the banks to replace their
unsecured borrowings with secured ones. The buildup of year to date profits,
capital injections by a few banks for meeting the minimum capital requirements (MCR),
and improvements in revaluation surpluses led to a stronger increase in
shareholders' equity and net worth. Accordingly, the leverage of the system
slightly came off.

Advances of the banking system declined
slightly during the quarter under review. Unlike last quarter's strong growth in
public sector advances, the decline was observed both in public and private
sector advances. Due to low aggregate demand in the economy as well as abroad,
high borrowing costs on account of tight monetary policy, unresolved political
and security issues, and the heightened credit risk in the economy, banks'
lending to private sector reduced significantly. This reduction has been mainly
taken up by public sector enterprises and commodity operations. Though aggregate
advances showed reduction during the quarter under review, dynamics of different
components and end-uses of advances show some instructive trends. The corporate
sector, specifically the private sector corporations in energy & power sector,
has in fact increased the bank borrowings while reduction in overall advances
portfolio mainly came from small and medium enterprises and consumer finance.
Accordingly, the segment-wise composition of advance with slight change remained
dominated by corporate sector. The end-use analysis of advances shows that
reduction in advances mainly occurred in working capital finance, while fixed
investments and trade finance showed increase. This development indicates some
revival in the entrepreneurs' confidence in the economy. Moreover, the reduction
in working capital in itself could be traced to the reduction in commodity
prices.

Investments, particularly the
investment in government papers and bonds of public sector utility corporations,
have been attracting increased preference of banks since the last quarter of
CY08. During the quarter under review, the investments again posted a strong
increase of over 13% mainly in the government papers followed by bonds of public
utilities and a marginal increase in equity investments. The further breakup of
GoP papers indicates that short-term market treasury bills were the focus of
banks' preference. The level of longer term Pakistan investment bonds, which are
subject to higher market risk and carry limited eligibility for the statutory
liquidity reserve requirement, remained stable. However, banks ability to ensure
smooth flow of credit to productive sectors of the economy and build up their
portfolio of earning assets remained largely dependent on their ability to
mobilize additional deposits and divert assets from liquid assets to loans and
advances.

The asset quality of the banking system
further deteriorated during the quarter. Owing to a number of factors including
the continuous recessionary trends, poor law and order situation, energy
shortfall and uncertain external environment, the system has been experiencing a
consistent and significant increase in NPLs for quite some time. Since there was
a reduction in overall lending portfolio of banks, the infection ratio (NPLs to
loans) of the system further inched up.

The group wise analysis shows decline
in advances of all groups except specialized banks. Foreign banks' portfolio in
relative terms witnessed the most significant decline. However, the relative
share of different groups in the overall loan portfolio remained stable.
Similarly, the reduction in loans and advances was prevalent in all banks,
irrespective of their size.

The decrease in lending is shared both
by private and public sector. Advances to private sector continued its declining
trend. However, there was a marginal decline of one percent in public sector
lending, which is contrary to last quarter growth of nearly 68%. The declining
trend in lending to private sector can be associated with a combination of
higher financing costs, the risk aversion by banks and attractiveness of risk
free avenues of government papers, bonds of and lending to public sector
enterprises. However, the composition of public sector and private sector
advances in overall mix showed negligible changes on QoQ basis. Domestic and
foreign composition of advances shows that the decline in overall advances has
been somewhat neutralized by a healthy increase of over 16% in foreign advances.

Outlook of the commercial banking
sector is highly dependent on the performance of the economy. Forecast of less
than 3% growth of GDP, persistent load shedding of electricity and gas and
investors' shyness do not bode well for the sector. Growing NPLs will also
continue to haunt the bankers.